Agency Musings

March 27th, 2008 10:45 am | by John Jansen |

 Agency debt is about unchanged versus Libor today amidst light activity.

Traders note that there is an expectation of some supply early next week with Freddie Mac scheduled to announce a deal. Traders are expecting $4billion 3 years.

Separately , it is interesting to speculate on the near term direction of agency spreads in view of the dramatic improvement they have undergone recently. Is this a selling opportunity or is there still value here? One strategist with whom I spoke had an interesting take on the topic.

He felt that notwithstanding the recent tightening agencies remain good value. He suggests a win/win scenario for owning this paper. So in the event that general credit conditions improve the debt of the GSEs will get swept up in that wave.

If the credit cycle takes an appreciable turn for the worse he believes the the agencies are protected because the very fact that the Treasury and the Fed acted with such alacrity to stave off the untimely and uncoordinated collapse of Bear Stearns assures that the powers that be would be there to save the agencies if a similar cruel fate overtook them.

What if spreads ratchet out in the meantime? If a crisis were to occur it would probably be of the rolling variety and if that were the case there would be interim government steps to shore up both FNMA and Freddie . That would prevent spreads from getting too wide.

The recent action by OFHEO which reduced some of the capital constraints on the balance sheets of the lenders is an example of governmental involvement which would only increase if circumstances changed. And the regulators have urged FNMA and Freddie Mac to issue preferred stock which might be the very first step in a process which could ultimately sacrifice the common  shareholders.

The ultimate solution is for the Federal Government to nationalize the agencies at which point agency paper should trade right on top of Treasuries. I am not calling for that but given that that option might someday be on the table, it limits the downside of owning this paper.

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